Obama's Tax Cuts Reveal Ignorance of Past Mistakes

Eager to revive an economy burdened by too much government spending, too much regulatory and tax uncertainty, and a weak, unstable dollar that makes job-creating investment a distant object, President Obama has announced an economic plan in favor of tax cuts. Although many on the right have curiously joined the President in support of these tax subsidies dressed up as cuts, the bipartisan support shouldn't fool anyone.  These tax cuts will not work.

At first glance individuals with a limited sense of economic history should be able to easily see the first obvious problem with the cuts proposed, and it's related to what occurred with Cash for Clunkers, along with the more recent tax breaks to stimulate home buying. Governments can't create economic growth, but when it comes to car and home-buying incentives, they can surely reschedule purchases of both.

The problem, as became evident once the auto and property purchase incentives expired, was that sales of both declined in concert with the end of the tax break. Incentives matter despite the view within Washington that workers don't respond to incentives such as lower income taxes with more economy-enhancing work.

So in offering a one-year window through 2011 for businesses to write off plant and equipment purchases, the Obama administration may be able to increase both in the near term. Markets, however, discount what's ahead as opposed to the present, which means they won't be fooled by earnings that will be stolen from the future both for those who buy, and those purchased from.

And while it would be similarly foolish if the Obama administration were to offer tax breaks for hiring (successful businesses as a rule try to get by with the least number of workers as possible, not to mention that the artificial tax break might drive up the cost of labor for other struggling businesses) as some Republicans who should know better are suggesting it do, the unseen when it comes to increased investment in plant and equipment is that it has the potential to draw limited capital away from spending on human capital. In short, equipment-buying incentives will be stimulated in concert with depressed hiring.

Also not addressed by the Administration is the simple truth at present that finance for business expansion is relatively cheap. If there's no incentive to grow during a period of low-cost loans, it seems folly to presume that a one-year tax incentive would accomplish very much. It also remains the case that expansion is a non-starter for most businesses owing to the regulatory, tax and dollar uncertainty mentioned above.

Sadly, the reality of Obama's tax plan gets worse from here.

Most problematic assuming companies buy what they don't necessarily need will be its impact on other, younger businesses in need of capital to grow. Indeed, the often unseen negative that results from high taxes on dividends (set to rise to 39.6% in 2011) is that they create incentives among businesses to retain earnings rather than give them back to investors.

The impact here is plain to see in that rather than pay out presently unnecessary cash to investors who would very likely reinvest it in other, more promising ventures, high taxes on dividends block the natural flow of capital to its highest use. Much the same may well occur if Obama's tax plan is passed. Instead of returning excess cash to shareholders who would subsequently reinvest it, non-economic investment will on the margin be subsidized by Washington tax mischief.

But the biggest problem with the Obama tax plan is that it addresses an economy that most sentient minds would no longer recognize. To put it very simply, we're increasingly an economy of the mind, rather than one where economic energy comes from heavy plant and equipment. Examples supporting this claim abound.

Noted Wall Street whipping boy Goldman Sachs derives a microscopic portion of its market cap from plant and equipment; rather its appeal to investors concerns the human assets who ride its elevators each day and who are widely seen as the foremost experts when it comes to investment banking, trading and money management.

Considering shipping giant FedEx, no doubt it spends enormous sums on airplanes, but its major assets are the supreme intellects in its employ whose operational brilliance enables its fleet of planes to deliver packages around the world.

Dell is said to be a computer company, but its true genius has to do with the individuals who oversee its efficient inventory management, which allows it to sell a product (the computer) on the relative cheap. So while Dell's computers are of impressive quality, its products are secondary to cash and inventory controls that make the sale of its products so profitable.

Looking at Google, Forbes publisher Rich Karlgaard long ago observed that the venerated Internet darling operates on "100 cheap servers." Taking nothing away from Google's wonderful "Googleplex" in northern California, its headquarters and all the equipment it houses could disappear tomorrow and the company wouldn't miss a beat. Interviews for prospective Google employees are legendary for their difficulty precisely because the company's most valuable assets are its employees.

So while President Obama will doubtless generate a great deal of good will from his usual media and economic enablers for "doing something", his latest tax plan ignores the kind of economy that ours has become, on its best day it will merely reschedule presumed "economic growth", and on its worst day it will create incentives among companies to retain the very earnings they should give back to shareholders on the way to investment in tomorrow's blue chip firms. It won't happen, but Obama would serve the economy and his presidency better if he simply did nothing short of demanding that Congress fulfill its constitutional mandate of ensuring a stable dollar.

Absent a dollar fix, the President should simply take a vacation from economic policy for the rest of 2010. Indeed, our economy doesn't suffer an inactive president; rather it's being weakened by a president eager to do too much.